Bonds give up gains as equities prove resilient

An earlier rally for fixed income fuelled by weak growth and output data faded as equity investors proved a resilient bunch on Tuesday. There were blatant signs of worry sounding from central bankers in Britain and Australia as they warned about the potential for dislocation stemming from fragile financial markets. Although such worries might be warranted, investors seem to be of the belief that having stood the strain of last week, perhaps we’re already beyond the point of maximum stress.

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Eurodollar futures – July housing starts dipped from a downwardly revised June number to a 604,000 annualized pace. Meanwhile the forward-looking picture did little to spur hopes for a sustained recovery as building permits also eased to 597,000. The housing market along with its bloated inventory overhang continues to feel the currents buffeting it around the ocean floor. September Treasury futures remain afloat after yields rose Monday when equities advanced. Currently, equity prices are erasing earlier losses but bond buyers can’t help advance prices to shave three pips off the 10-year yield to 2.27%. Industrial output snapped back during July as factories increased production as the supply-chains came back online in the aftermath of the Japanese earthquake. Remarkably hot weather also boosted energy production across the nation leading to a monthly gain in industrial production of 0.9% and so almost twice the predicted pace. Capacity utilization also strengthened to 77.5% from 76.9% of overall capacity.

European bond markets – German bunds remain higher but are off the day’s best levels with the yield declining by just one basis point to 2.31%. Both German and Eurozone second-quarter gross domestic product sadly lacked the vim and vigor of the previous quarter and was greeted by jaw-dropping disappointment by investors who were quick to sell out of short-term gains in equities and clutch at the safety of government bonds. Later in the day the ECB appeared to be at work lifting Italian and Spanish government debt in the secondary market and providing a silver lining to the day’s trading. The GDP data poses questions at Tuesday’s Merkel-Sarkozy meeting in Paris. Most would like the pair to announce a joint initiative to pave a revolution for European government financing along the lines of mutual guarantees for joint issues of Eurobonds. Both nations have previously rejected such moves and it’s unlikely that last week’s now-subsided volatility will force them to undergo a change of mind. According to French Finance Minister Baroin the two will discuss how to expand the coordination of national policies and tightening of budget rules within the euro-area.

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